Schwab Buying Bank That Caters to the Rich / U.S. Trust deal would be biggest broker takeover

Sam Zuckerman, Chronicle Staff Writer

Published
4:00 am PST, Friday, January 14, 2000

In a high-profile marriage of new money and old, online trading giant Charles Schwab Corp. agreed yesterday to buy U.S. Trust Corp., one of the nation's largest managers of money for the wealthy, for $2.7 billion in stock.

If approved, the deal would be the nation's largest takeover of a bank by a brokerage firm -- just the sort of combination anticipated when Congress rewrote banking laws last year to make it easier to create bank, brokerage and insurance hybrids. Although it markets itself as a trust company, U.S. Trust, founded in 1853 and based in New York, is chartered as a bank and has banking powers.

The takeover also marks another triumph of the new economy over the old.

"This merger is as important for financial services as AOL and Time Warner were for entertainment," said Charlotte Chamberlain, an analyst with the Los Angeles brokerage Jefferies & Co. "This is a watershed merger in financial services, joining together online and old line."

Like AOL, Schwab is using its stock -- inflated by its Internet status -- to buy a more traditionally valued firm. Schwab's stock traded at about 45 times projected earnings for the year, compared with 19 times earnings for U.S. Trust's stock before the purchase was announced.

To be sure, Schwab is not a pure Internet company. It began 26 years ago as a discount broker offering cheap commissions on stock trades for customers who made their own investment decisions, emerging as the strongest competitor in that field.

The company still has extensive branch and telephone operations, but customers now enter more than 2 out of 3 stock orders over the Internet, and Schwab has emerged as the dominant force in online brokerage.

The unlikely pairing of the leading mass-market discount broker and a prestigious, old-fashioned money manager is not as strange as it seems, analysts said.

Schwab will be able to offer its customers banking products, such as federally insured deposits, although U.S. Trust's status as a trust company, not a full-service bank, may restrict Schwab's ability to provide a full range of bank services.

In addition, U.S. Trust's research department, which includes about 20 stock analysts who follow 300 companies, gives Schwab the building blocks for in-house stock analysis, a service investors demand. Currently, Schwab provides stock research from outside firms only.

Officials have not yet decided whether Schwab will give stock reports to all customers or just top-tier clients. "My guess is it will be available to everybody," said U.S. Trust Vice Chairman Maribeth Rahe.

Schwab's main reason for scooping up U.S Trust is to capture a market segment is has coveted but never conquered -- the wealthiest Americans.

For clients with $2 million or more, U.S. Trust manages investment portfolios, does estate and tax planning, creates trust accounts and offers individually tailored banking services, including loans and checking accounts. It charges clients hefty fees for the services.

In recent years, Schwab has tried to upgrade the services it offers its wealthiest -- and most profitable -- customers, giving them individual service representatives and a variety of frills, such as opportunities to chat with corporate CEOs in conference calls. But given its discount- broker origins, Schwab's culture and business model make it difficult to provide the kind of coddling rich clients want.

As their assets have grown, many Schwab customers have defected to trust companies and high-end brokers such as Merrill Lynch. Even so, Schwab has more rich customers than ever, thanks to a soaring stock market. Now Schwab will be able to refer them to U.S. Trust, which will retain its identity after the takeover.

"We're increasingly getting wealthy clients," said co-Chief Executive David Pottruck. "We need services we have not traditionally been able to provide."

Analysts say Schwab's move positions it to grab a bigger share of the wealth market.

Still, Schwab faces a potential revolt among one of its key constituencies -- the 4,600 independent financial advisers who provide personal investment advice to Schwab customers for a fee. About 30 percent of Schwab's assets are managed by these advisers, and many of them may feel threatened if the firm can refer clients to U.S. Trust.

"It was a shock," said one such adviser, Morgan White of Menlo Park's Woodside Asset Management about the U.S Trust purchase. "That's our market."

Schwab is working overtime to assure the advisers that their business will actually be helped by the purchase. Advisers "have been telling us for years that we need to have trust services," said Pottruck.